NEW YORK—The stock market’s gyrations have grabbed the year-end headlines, but another key financial market, investment-grade U.S. corporate debt, is turning in its worst yearly performance since the financial crisis a decade ago.
General Electric Co.’s securities have weighed on both markets as the 126-year-old conglomerate founded by Thomas Edison has suffered staggering losses and asset writedowns.
GE shares have skidded around 56 percent in 2018, the fourth-biggest decline in the S&P 500 Index. GE’s $120 billion of bonds are not down as much, but the securities, which have long been a staple for fixed income managers around the globe, are among the leading drags on the main indexes tracking the $6 trillion investment-grade corporate debt sector.
GE’s bonds have crashed by around 14 percent—a monumental underperformance in bond market terms. Analysts worry this could signal worse times ahead for investment grade credit overall. According to the Bank of America/Merrill Lynch index, the sector’s total 2018 return is negative 2.5 percent, the largest drop since 2008.
U.S. companies feasted on low-interest rates in the decade since the crisis, leaving corporate balance sheets leveraged to the hilt with some $9.1 trillion of debt, almost double the 2007 total of $4.9 trillion, according to Securities Industry and Financial Markets Association.
Now the Federal Reserve’s gradual tightening of its easy-money policy has investors rethinking their commitment to these assets. Bonds from dozens of formerly high-quality issuers are already trading as though they were no longer investment grade.
As interest rates rise, “the weaker links are going to be exposed,” said Kathleen Gaffney, director of diversified fixed income at Eaton Vance.
After this year’s sharp slide in GE shares, its debt load now stands at roughly twice its market capitalization of $63 billion.
Keeping Plenty of Company
GE’s debt is not alone in the doghouse.
Bonds from Ford Motor Co., AT&T Corp., Kinder Morgan, CVS Health, General Motors Co., and Verizon Communications also ranked among the weakest performers as the year wound down. Of the bottom 20 performers, 14 were triple-B rated, the lowest tier of investment grade. GE debt has been slashed to BBB+ which is just three steps above junk, and more than a third of GE’s bonds are already trading at junk bond levels.
Bonds most likely to be downgraded to junk are expected to be among the worst performers when the next economic downturn hits, according to Monica Erickson, portfolio manager of global developed credit at DoubleLine Capital LP.
She noted that around $3 trillion of triple-B bonds are now outstanding, comprising roughly half of the investment grade market, up from only about 20 percent a decade ago.
“With the triple-B market worth about $3 trillion, finding a buyer in the $1.2 trillion high-yield market could be difficult” in a downturn, she said. Many fund managers are required to keep only investment-grade debt in their portfolios, so they could be forced to sell at steep discounts if the debt gets downgraded to junk.
Currently, the junk market totals $1.2 trillion. Were GE to lose investment grade status, those bonds alone would suddenly account for around 10 percent of the high-yield market.
Not all triple-B credits will be downgraded in the event of a downturn, however, “you will probably have a larger percentage of this entire (investment grade) market shift into this high-yield market than has been the case historically,” Erickson said.
How Much GE Do You Own?
GE’s new Chief Executive Officer Larry Culp is battling to restore profits and slash debt after the company lost $22.8 billion last quarter, mostly from its ailing power unit.
To shore up cash, it has slashed its once-fat quarterly dividend to just a penny per share, and Culp said GE would proceed with “urgency” on selling assets.
Those efforts have so far fallen short in the eyes of bond holders and credit ratings agencies.
In response to a request for comment, a GE spokesperson referred to Culp’s statements in its third-quarter earnings report and in recent media interviews about debt-reduction plans.
All three major bond raters have slashed GE’s credit ratings twice in the last 13 months. It is now labeled “BBB+” by Standard & Poor’s, with equivalent ratings from Moody’s and Fitch.
Roughly $43 billion worth of GE bonds sport prices of less than 90 cents on the dollar, with more than $17.5 billion selling for less than 80 cents. The lowest, a $2 billion perpetual bond sold in 2015, is currently quoted at about 63 cents on the dollar and now yields 17.5 percent versus its 4.1 percent coupon rate.
By comparison, the average triple-B bond yields 4.7 percent, according to BAML index data.
The cost to insure GE bonds against default is near the highest since the financial crisis. Yet the biggest risk facing bond investors is being unable to sell their holdings if the company’s credit fundamentals worsen.
“You’ve got a lot of sellers and no buyers,” said a GE debt investor who asked not to be named because of compliance reasons. And so “we have not yet sold our debt holdings.”
“You’ve seen people head toward the exit, and there’s not a buyer, so you get a big trade down,” the investor said. “Everyone’s getting questions from their boss or their client asking ‘how much GE do you own?'”
By Kate Duguid